1. Describing Demand and Supply: Elasticities
Chapter 6

2. The Concept of Elasticity
Elasticity is a measure of the responsiveness of one variable to a change in another.
The most commonly used elasticity concept is price elasticity of demand.

3. Price Elasticity
The price elasticity of demand is the percentage change in quantity demanded divided by the percentage change in price.

4. Things to Note About Elasticity
Price elasticity of demand is always negative because price and quantity demanded are inversely related—when price rises, quantity demanded falls, and vice versa.

5. Things to Note About Elasticity
Economists have developed a convention and talk about price elasticity of demand as an absolute value of the number.
Thus, price elasticity of demand is reported as if it were positive.

6. Classifying Demand as Elastic or Inelastic
It is helpful to classify demand by relative responsiveness as elastic or inelastic.

7. Elastic Demand
For elastic points on curves, the percentage change in quantity is greater than the percentage change in price, in absolute value.
D > 1

8. Elastic Demand
Common sense tells us that an elastic demand means that quantity changes by a greater percentage than the percentage change in price, in absolute value.

9. Inelastic Demand D < 1
For inelastic points on curves, the percentage change in quantity is less than the percentage change in price, in absolute value.
D < 1

10. Inelastic Demand
Common sense tells us that an inelastic demand means that the percent change in quantity is less than the percentage change in price, in absolute value.

11. Elasticity Is Independent of Units
Elasticity is calculated as a ratio of percentages.
Percentages allow us to have a measure of responsiveness that is independent of units.

12. Elasticity Is Independent of Units
Having a measure of responsiveness that is independent of units makes comparisons of responsiveness of different goods easier.

13. Calculating Elasticities
To determine elasticity, divide the percentage change in quantity by the percentage change in price.

14. The Mid-point Formula
Using the mid-point formula, the average of the two end points are used when calculating percentage change.

15. Graph of Price Elasticity of Demand, Fig.6-1a, p 136B
$26
C (midpoint) 23 A
Price 20 D 5 7 9
Quantity of software (in thousands)
Elasticity of demand = 1.3

16. Graph of Price Elasticity of Demand, Fig.6-1b, p 136
$10 B 9
D = 4 8 A 7 6
Price C 5
D = 0.54 4 3 2 D 1
b) Some examples
Quantity

17. Calculating Elasticity at a Point
Let us now turn to a method of calculating the elasticity at a specific point, rather than over a range.

18. Calculating Elasticity at a Point
To calculate elasticity at a point, determine a range around that point and calculate the elasticity using the mid-point formula.

19. Calculating Elasticity at a Point, Fig a) p 138
Price
Quantity
$10 9 8 7 6 5 4 3 2 1 C B A 24 40 28 20

20. Calculating Elasticity at a Point Fig b) p 138
$10
Demand 9
D= 2.33 8 A 7 6 5
Price 4
D = 0.11 3 2 B 1 6 12 18 24 30 36 42 48 54 60
Quantity

21. Elasticity and Demand Curves
Two important points to consider:
Elasticity is related to (but is not the same as) slope.
Elasticity changes along a straight-line demand curve.

22. Elasticity Is Not the Same as Slope
The relationship between elasticity and slope means that the steeper the curve, the less elastic is demand.
There are two limiting examples of this.

23. Elasticity Is Not the Same as Slope
When the curve is horizontal, it is perfectly elastic.
Perfectly elastic demand is a horizontal line in which quantity changes enormously in response to any change in price (D = ¥).

24. Elasticity Is Not the Same as Slope
When the curve is vertical, we call the demand perfectly inelastic.
Perfectly inelastic demand is a vertical line in which quantity does not change at all in response to a change in price (D = 0).

25. Perfectly Inelastic Demand Curve, Fig 6-2a, p 139
Price
Quantity
Perfectly inelastic demand curve

26. Perfectly Elastic Demand Curve Fig 6-2b, p 139
Price
Quantity
Perfectly elastic demand curve

27. Elasticity and slope, Fig.6-3, p 140
$10
Over the $3 to $4 price
interval, D (D1) = 0.47
while D (D2) = 4.2 9 8 7 6
Price 5 G C 4 A 3 2 D1 D2 1
Quantity

28. Elasticity Changes Along Straight-Line Curves
Elasticity is not the same as slope.
Elasticity changes along the straight line supply and demand curves—slope does not.

29. Elasticity Changes Along Straight-Line Curves
A demand curve is perfectly elastic ( D = ¥) at the vertical (price) intercept.
Elasticity becomes smaller as you move down the demand curve until it becomes zero ( = 0) at the horizontal (quantity) intercept.

30. Elasticity Along a Straight Line Demand Curve Fig 6-4, p 141
$10
Elasticity declines along demand curve as we move toward the quantity axis 9 8
 D > 1 7 6
 D = 1 5
Price 4 3
 D < 1 2 1
 D = 0 1 2 3 4 5 6 7 8 9 10
Quantity

31. Interpreting elasticities
We know by the law of demand that consumers buy less as price rises
Price elasticity of demand tells us if whether consumers reduce their purchases by a lot (elastic demand) or a little (inelastic demand).

32. Interpreting Price Elasticity of Demand, Table 6-1, p 141
Description of demand
Interpretation
D=¥
Perfectly elastic
Quantity responds enormously to changes in price
D>1
Elastic
Consumers are responsive to price changes
D=1
Unit elastic
Percent change in price and quantity are equal
D<1
Inelastic
Consumers are unresponsive to price changes
D=0
Perfectly inelastic
Consumers are completely unresponsive to price change

33. Substitution and Price Elasticity of Demand
As a general rule, the more substitutes a good has, the more elastic is its demand.

34. Substitution and Price Elasticity of Demand
How many substitutes a good has is affected by many factors:
Time to Adjust
Luxuries versus Necessities
Narrow or Broad Definition
Budget Proportion

35. Time to Adjust
The larger the time interval considered, or the longer the run, the more elastic is the good’s demand curve.
There are more substitutes in the long run than in the short run.
The long run provides more options for change.

36. Luxuries versus Necessities
The less a good is a necessity, the more elastic its demand curve.
Necessities tend to have fewer substitutes than do luxuries, so their demand is less elastic.

37. Narrow or Broad Definition
As the definition of a good becomes more specific, demand becomes more elastic.
If the good is broadly defined—for example, transportation—there are not many substitutes and demand will be inelastic.

38. Narrow or Broad Definition
As the definition of a good becomes more specific, demand becomes more elastic.
If the definition of a good is narrowed—to travel by bus, for example—there are more substitutes.

39. Budget Proportion
Demand for goods that represent a large proportion of one's budget are more elastic than demand for goods that represent a small proportion of one's budget.

40. Budget Proportion
Most people shop around for the lowest price on expensive items – the demand elasticity is large for those goods.
It is not worth spending the time looking for substitutes for goods which do not take much out of one’s income.

41. Empirical Estimates of Elasticities
The following table provides short- and long-term estimates of elasticities for a number of goods.

42. Empirical Estimates of Elasticities, Table 6-2, p 143

43. Price Elasticity of Demand and Total Revenue
Total revenue is the total amount of money a firm receives from selling its product.
Revenue equals total quantity sold multiplied by the price of good.
Knowing the elasticity of demand is useful to firms because from it they can tell what happens to total revenue when they raise or lower their prices.

44. Price Elasticity of Demand and Total Revenue
If demand is elastic ( D > 1), a rise in price lowers total revenue.
Price and total revenue move in opposite directions.

45. Price Elasticity of Demand and Total Revenue
If demand is unit elastic ( D = 1), a rise in price leaves total revenue unchanged.

46. Price Elasticity of Demand and Total Revenue
If demand is inelastic ( D < 1), a rise in price increases total revenue.
Price and total revenue move in the same direction.

47. Elasticity and Total Revenue Fig. 6-5a, p 144
Elastic Demand
 D > 1
$10 F E C 8
Gained revenue A B 6
Price 4
Lost revenue 2 1 2 3 4 5 6 7 8 9
Quantity

48. Elasticity and Total Revenue Fig. 6-5b, p 144
Inelastic Demand
 D < 1
$10 8 6
Price
Gained revenue
Lost revenue 4 H 2 G C A B 1 2 3 4 5 6 7 8 9
Quantity

49. Elasticity and Total Revenue Fig. 6-5c, p 144
Unit Elastic Demand
 D = 1 6
Price
Quantity
$10 8 4 2 1 3 5 7 9 K
Gained revenue C J
Lost revenue A B

50. Total Revenue Along a Demand Curve
Demand is elastic at prices above the middle point where demand is unit elastic – a rise in price in that range lowers total revenue.
Demand is inelastic at prices below the middle point where demand is unit elastic – a rise in price in that range increases total revenue.

51. How Total Revenue Changes Along a Demand Curve Fig. 6-6, p 145TR
Elastic range
 D > 1
 D = 1
Inelastic range  D < 1 Q0
Quantity Q0
Quantity
(a)
(b)

52. Elasticity of Individual and Market Demand
Market demand elasticity is influenced both by:
How many people reduce their quantity to zero when price increases.
How much an existing consumer marginally changes his or her quantity demanded.

53. Elasticity of Individual and Market Demand
Price discrimination occurs when a firm separates the people with less elastic demand from those with more elastic demand.

54. Elasticity of Individual and Market Demand
Firms that price discriminate can charge more to the individuals with inelastic demand and less to individuals with elastic demand.

55. Elasticity of Individual and Market Demand
Examples of price discrimination include:
Airlines’ Saturday stay-over specials.
Selling new cars at a discount.
The almost-continual-sale phenomenon.

56. Other Elasticities of Demand
Two other demand elasticities are important in describing consumer behaviour:
Income elasticity of demand.
Cross-price elasticity of demand.

57. Income Elasticity of Demand
Income elasticity of demand is defined as the percentage change in demand divided by the percentage change in income.

58. Income Elasticity of Demand
Income elasticity of demand tells us how demand responds to changes in income.

59. Income Elasticity of Demand
An increase in income generally increases one’s consumption of almost all goods, although the increase may be greater for some goods than for others.

60. Income Elasticity of Demand
Normal goods are those goods whose consumption increases with an increase in income.
They have income elasticities greater than zero (positive).

61. Income Elasticity of Demand
Normal goods are usually divided into two categories:
luxuries and
necessities.

62. Income Elasticity of Demand
Luxuries are goods that have an income elasticity greater than 1.
Their percentage increase in quantity demanded is greater than the percentage increase in income.
They are an “income elastic normal good”.

63. Income Elasticity of Demand
Shoes are a necessity—a good that has an income elasticity less than 1, but still positive (shoes are an “income inelastic normal good”).
The consumption of a necessity rises by a smaller proportion than the rise in income.

64. Income Elasticity of Demand
Inferior goods are those whose consumption decreases when income increases.
Inferior goods have income elasticities less than zero (negative).
Generic (store-brand) cereals are one example of inferior goods.

65. Income Elasticities of Selected Goods, Table 6-3, p 148

66. Interpreting Income Elasticity of Demand,Table 6-4, p 149
Coefficient
Interpretation
Description
Normal good
 I   Qd
Two cases of normal good:
Income inelastic normal good (“necessity”)
Income elastic normal good (“superior” good)
Inferior good
 I   Qd

67. Cross-Price Elasticity of Demand
Cross-price elasticity of demand is computed by dividing the percentage change in quantity demand by the percentage change in the price of another good.

68. Cross-Price Elasticity of Demand
Cross-price elasticity of demand tells us the responsiveness of demand to changes in prices of other goods.
Cross-price elasticity measures both how and how strongly consumers respond to changes in the price of related products.

69. Cross-Price Elasticity of Demand
Depending on how consumers respond to changes in the price of related products, goods can be classified as
Substitutes or
Complements

70. Complements and Substitutes
Substitutes are goods that can be used in place of one another.
When the price of a good goes up, the demand for the substitute good also goes up.
Cross-price elasticity of substitutes is positive

71. Complements and Substitutes
Complements are goods that are used in conjunction with other goods.

72. Complements and Substitutes
A rise in the price of a good will decrease the demand for its complement, and a fall in the price of a good will increase the demand for its complement.
The cross-price elasticity of complements is negative.

73. Interpretation of Cross-Price Elasticity Table 6-5, p 150
Coefficient
Interpretation
Ratio
XY > 0
Substitute
Goods
PYQX
XY < 0
Complementary
PY QX
XY = 0
Unrelated Goods
PY  QX=0

74. Calculating Income and Cross-Price Elasticities,Fig 6-7a, p 151
=6.5 P0 P0
Shift due to rise in income D0 D1 18 25
Quantity

75. Calculating Income and Cross-Price Elasticities,Fig 6-7a, p 151
Price of
ketchup
Shift due to rise in price
of hot dogs
XY= -0.7 P0 P0 D0 D1 3 4
Quantity of ketchup

76. Price Elasticity of Supply
Measures the responsiveness of firms to a change in the price of their product.

77. Price Elasticity of Supply
The price elasticity of supply is calculated as the percent change in quantity supplied over the percent change in price.

78. Inelastic Supply
Common sense tells us that an inelastic supply means that the percent change in quantity is less than the percentage change in price.

79. Elastic Supply
An elastic supply means that quantity supplied changes by a larger percent than the percent change in price.

80. Substitution and Supply
The longer the time period considered, the more elastic the supply.

81. Substitution and Supply
The reasoning is the same as for demand.
In the long run there are more alternatives so it is easier (less costly) for suppliers to change and produce other goods.

82. Substitution and Supply
Economists distinguish three time periods relevant to supply:
The instantaneous period.
The short run.
The long run.

83. Substitution and Supply
In the instantaneous period, quantity supplied is fixed so supply is perfectly inelastic.
This supply is sometimes called the momentary supply.

84. Substitution and Supply
In the short run, some substitution is possible, so the short-run supply curve is somewhat elastic.

85. Substitution and Supply
In the long run, significant substitution is possible; the supply curve becomes very elastic.

86. Substitution and Supply
An additional factor to consider in determining elasticity of supply:
One must take into account how easy or how difficult it is to produce more of the same good. The easier it is to produce additional units, the more elastic the supply.

87. Empirical Estimates of Elasticities
There are fewer empirical measurements of elasticity of supply than there are of demand elasticities.

88. Effects of Shifts in Supply on Price and Quantity
An example of the importance of elasticities of demand and supply can be illustrated by the example of the world market for oil

89. Effects of Shifts in Supply on Price and Quantity
If oil supply decreases, the world prices will rise sharply if the demand for oil is inelastic
Oil prices will not be affected a lot if demand is elastic

90. Effects of Shifts in Supply on Price and Quantity, Fig 6-8a, p 154
Inelastic Supply and Inelastic Demand P1 P0
Price
Quantity S1 S0 Q1 Q0
Demand

91. Effects of Shifts in Supply on Price and Quantity, Fig 6-8b, p 154
Inelastic Supply and Elastic Demand S1 S0
Price
Demand P1 P0 Q1 Q0
Quantity

92. Describing Supply and Demand: Elasticities
End of Chapter 6